Enron was formed in 1985 following the merger of Houston Natural Gas Co. and Omaha, InterNorth Inc.

based in Neb. Following the merger, Kenneth Lay, who served as chief executive officer (CEO) of
Houston Natural Gas, became CEO of Enron.

Deregulation of the energy market allows companies to bet on future prices, and Enron is poised to take
advantage. In 1990, Lay founded Enron Finance Corp. and appointed Jeffrey Skilling, who served as an
advisor to McKinsey & Co. impressed Lay, as the head of the new corporation. Skilling was then one of
the youngest partners at McKinsey.

Mark-to-Market

Skilling joined Enron at a good time. Two years later, Skilling created a new accounting technique known
as market-based accounting (MTM), which was officially licensed by the U.S. Securities and Exchange
Commission (SEC) in 1992. The regulatory environment The minimal logic of the times allowed Enron to
flourish.

The MTM accounting technique allows a company to adjust the value of assets on its balance sheet from
their historical value to their current fair market value (FMV), and thus means Income can be calculated
as an estimate of the present value of future net cash flows.

However, in some cases this method can be manipulated, as the MTM is not based on “actual” costs but
on “fair value”, which is more difficult to determine. Some believe that the MTM is the beginning of the
end for Enron, as it essentially allows the organization to recognize estimated profits as actual profits.

For example, if a contract is worth $100 million over the next 10 years, MTM accounting will allow a
company to put $100 million on its books on the date the contract is signed, regardless of whether the
agreement in the end match the expectation or not. As a result, Enron was able to increase its current
value through financial statements, which were essentially and above what it actually earned,
obfuscating the truth about its business performance.

In the late 1990s, the dotcom bubble exploded and the NASDAQ hit 5,000. Internet revolutionary stocks
are being priced at irrational rates and as a result, most investors and regulators simply accept the
skyrocketing share price as the new normal.

Blockbuster MTM accounting techniques in Enron Broadband Services

This is perhaps more clearly illustrated when Enron Broadband Services, a subsidiary of Enron, partnered
with Blockbuster in July 2000 in a 20-year agreement to sell movie-on-demand services through your
broadband network. The use of the MTM accounting technique meant that Enron was able to include all
of its projections for the next 20 years from the deal — in this case, $110 million in estimated profit — in
its mid-2000s financial statements.

But the partnership was eventually terminated after the studios expressed their opposition to
Blockbuster providing such services. However, the failed deal and Blockbuster's exit did not prevent
Enron from continuing to claim future profits and thus selling the company's stock at inflated prices,
even though the sale resulted in a loss. Arguably, this was the first major incident to initiate external
scrutiny of Enron's transactions and its suspicious MTM activities.
Ultimately, the unit's CEO, Joseph Hirko, and vice presidents F. Scott Yeager and Rex Shelby were
charged with conspiracy, fraud, insider trading, and money laundering in connection with those
activities. . And Kevin Howard, former chief financial officer (CFO), and Michael W. Krautz, former senior
accounting director at Enron Broadband Services, were charged with conspiracy and fraud related to the
fabrication of income derived from Blockbuster deal failed.

By mid-2000, EnronOnline (EOL) created by Enron for users to conduct electronic transactions focused
on goods had done nearly $350 billion in transactions. When the dotcom bubble began to burst, Enron
decided to build high-speed broadband telecommunications networks. Hundreds of millions of dollars
were spent on this project, but in the end the company realized that it was barely profitable.

When the recession hit in 2000, Enron had significant exposure to the most volatile parts of the market.
As a result, many trust investors and creditors find themselves falling into disrepair as market
capitalization disappears.

A series of consecutive mistakes

The company also used accounting tricks to misclassify loan transactions as revenue just before the
quarterly financial statement date.

Specifically, they entered into an agreement with Merrill Lynch in which the US bank purchased a
Nigerian barge with a buyback guarantee from Enron shortly before the earnings deadline. Enron
misreported the bridge loan as an actual sale before acquiring the barge a few months later. Merrill
Lynch was finally blamed in November for her role in supporting Enron in accounting fraud, with several
bank executives spending nearly a year in prison.

How did Enron hide his debt?

Chief Financial Officer Andrew Fastow with support from Skilling, Lay and the board orchestrated a
scheme to use off-balance sheet specialized vehicles (SPVs), also known as special purpose entities
(SPE), to hide Enron's mountains of malicious debt and assets from investors and creditors. The main
purpose of these SPVs is to conceal accounting reality rather than operating results.

Standard Enron-to-SPV Trading: Enron will convert some of its rapidly growing stock into SPV in
exchange for cash or a banknote. The SPV would then use the stock to protect an asset listed on Enron's
balance sheet. In return, Enron will guarantee the value of the SPV to reduce the apparent counterparty
risk.

Although their purpose is to conceal accounting facts, SPVs are not illegal. One key difference is that
SPVs are fully capitalized with Enron stock. This directly affects the hedging ability of the SPVs if Enron's
share price falls. Equally dangerous is the second significant difference: Enron's failure to disclose
conflicts of interest.

Enron's management believes its share price will continue to rise—a belief similar to that held by Long-
Term Capital Management, a large hedge fund, before its collapse in 1998. Enron's stock fell. The value
of the SPVs also decreased, forcing Enron's warranties into effect.
Later, Fastow announced to testify before the US Congress about the consequences of the scandal and
also confirmed that he himself "benefits greatly from the partnerships". Indeed, he pocketed about $45
million in operating profits. In January 2004, he confessed to two counts of fraud, agreed to a prison
sentence of up to 10 years and forfeited $24 million. “I became a hero for Enron. We used this to
increase our income.”

Enron's Bankruptcy Slope

The failed Blockbuster deal set off a gradual wave of scrutiny into the company's accounts from the
financial press. The Texas Journal published a story in September 2000 about the shortcomings and lack
of transparency surrounding MTM accounting techniques that are increasingly being adopted by the
energy industry.

Following that, the article “Is Enron Overvalued?” Questioned the company's stock valuation and
suggested that investors don't know exactly how Enron makes money, while the article's author,
Bethany McLean's concerns, were dismissed by Skilling when She tries to discuss her findings with him
before publishing the paper.

At the end of October, after analysts increasingly complained about the inconsistency in Enron's
financial statements, rating agency Moody's downgraded Enron's credit rating to just two levels below
the previous one. garbage status. Days later, the public revealed that the SEC had begun a formal
investigation into Enron and its dealings with "relevant parties."

By the end of November 2001, Enron's stock price had fallen below $1 per share, in stark contrast to its
mid-2000 peak of $90.75. The company is estimated to have $23 billion in liabilities from both
outstanding and guaranteed loans, fueling speculation that the company will have to declare
bankruptcy. Enron Europe, the parent company of Enron's operations in Continental Europe, was the
first to do so on November 30.

With total assets of $63.4 billion, Enron was the largest corporate bankruptcy in U.S. history until the
WorldCom scandal just a year later. About 4,000 jobs have been lost, and nearly two-thirds of the
15,000 employee savings plans that depended on Enron stock, which were purchased for $83 at the
start of the year, have become worthless.

Arthur Andersen was one of the first casualties in the infamous fall of Enron. Andersen allegedly failed
to apply sufficient standards in his audit of Enron's books and conducted himself in a way that simply
received his dues without adequately examining Enron's accounting practices. In June 2002, the
accounting firm was found guilty of obstruction of justice for shredding Enron's financial documents to
conceal them from the SEC.

It was eventually revealed that some conflict of interest had arisen between Andersen and Enron. In
particular, in Andersen's Houston office, where the audits were conducted, it was also discovered that
Enron's management had put considerable pressure on Andersen's auditors to meet earnings
expectations. its input.

Enron will hire other accounting firms shortly to perform some of the accounting tasks and thus give the
impression that it will replace Andersen. Shredding nearly 30,000 emails and other files after Enron's
negligence was discovered The testimony also raised suspicions of widespread collusion between the
two sides. In the end, Andersen's interference with Enron caused the accounting firm to fall apart, again
resulting in thousands of job losses.

Several Enron executives have been charged with conspiracy, insider trading and securities fraud. Lay,
founder and former chief executive officer of Enron, was convicted of six counts of fraud and conspiracy
and four counts of bank fraud. Before his sentencing, he died of a heart attack in Colorado.

Enron is the largest corporate bankruptcy in US history. Fastow, Enron's veteran former chief financial
officer, pleaded guilty to two counts of wire fraud and securities fraud for facilitating Enron's corrupt
business practices. In the end, he cut a partnership agreement with the federal government and spent
more than five years in prison.

Skilling, the former chief executive of Enron, ended up receiving the harshest sentence on charges of
conspiracy, fraud and insider trading. Skilling initially received a 17-and-a-half year sentence, but in 2013
it was reduced to 14 years. As part of the new settlement, Skilling was ordered to pay $42 million in
damages to victims of the Enron scam and stop challenging his conviction.

The collapse of Enron and the financial devastation it caused to its shareholders and employees led to
new regulations and laws aimed at promoting the accuracy of financial reporting for companies public
office. In July 2002, then-President George W. Bush signed into law the Sarbanes-Oxley Act. This act
increases the consequences of destroying, altering or falsifying financial statements and attempting to
defraud shareholders.

In the early 2000s, the collapse of Enron was the largest corporate bankruptcy ever to hit the financial
world. The Enron scandal drew attention to corporate and accounting fraud as its shareholders lost $74
billion in four years leading to bankruptcy and billions of dollars in lost employees. retirement benefits.
The shock waves across the markets shook investor confidence in its core and regulators forever after.

The story from the shocking Enron scandal teaches us a profound lesson about never owning just one
stock in a portfolio. No matter how compelling the company's story, the threat of an unexpected
reversal can overwhelm you at any moment. In particular, if you are an employee and own stock in your
company, make sure you understand how the company's business is going and be especially cautious
when buying and holding such stock.